Obtaining a loan for your small business is a great way to boost investment and even grow your business when the time is ripe. You might have heard some grumblings about small business loans: they're hard to obtain; your credit has to be flawless; don't ask for too much money or you'll be denied. Fortunately, these prominent myths surrounding small business lending aren't necessarily true.
It's important to manage debt properly, but doing so can help grow your business at a faster rate than scrimping and saving. To help you obtain a small business loan for your company, Business News Daily spoke with finance experts to debunk six common myths about getting a business loan.
Myth No. 1: Getting a small business loan is the hardest thing you'll ever have to do.
Like other forms of financing, obtaining a small business loan is all about preparation. Ensuring your books are transparent and you maintain the reserve liquidity to encourage the lender that you’ll be able to service your debt on time and consistently will lead to success. And experts agree the best way to avoid unnecessary snags is to prepare ahead of time for the application process.
"A lot of the frustration around obtaining small business financing can be eased by doing your due diligence," said Michael Adam, founder and CEO of Bankmybiz, a site that connects business owners with business funders. "Be prepared, and have all your documents ready to present to lenders." [See Related Story: Small Business Financing Trends: What You Need to Know]
Myth No. 2: You must have perfect credit to get a small business loan.
Low credit scores are a concern for some lenders, but banks aren’t the only lenders out there. Alternative and private lenders are often able to offer more flexible terms, including which level of creditworthiness they can approve.
"While traditional banks may be restrictive when it comes to obtaining credit, there are alternative options," said Michael Kevitch, president and founder of Small Business Funding.
Alternative lending sites such as Small Business Funding tend to base lending decisions on the financial realities of a business rather than the financial history of business owners. Specifically, Kevitch said, alternative lenders take a close look at business performance, industry type, time in business and cash flow before handing out a loan.
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Myth No. 3: The best way to obtain a loan for your business is through a bank.
Entrepreneurs have more than one option for obtaining financing; banks are not the only game in town. There are alternative and private lenders, as well as creative types of lending like invoice factoring, which can help business owners shore up their capital without going through the lengthy and restrictive application process required by conventional lenders.
For business owners looking to borrow a relatively small sum (between $5,000 and $250,000), getting a bank loan is likely to be more trouble than it's worth, Kevitch said. Banks are more suitable for businesses that are interested in borrowing a large amount of cash and repaying the loan over a long period of time at a relatively low interest rate. Kevitch advised business owners to make sure they fall under those categories before applying through a bank.
Instead, Kevitch said, alternative lending sources often provide faster approvals for shorter loan repayment periods; sometimes, businesses can obtain access to the funds in as little as seven days, he said. Because the terms are more flexible, interest rates are often higher.
Myth No. 4: The worst way to obtain a loan for your business is through a bank.
Just because you can obtain financing elsewhere, doesn’t mean conventional lenders and bank loans are not for you. Sometimes, a bank offers exactly the funding option you need. In fact, for established businesses looking to grow at a moderate rate, traditional bank funding is generally a great option, Adam said. It's when a business doesn't fit those criteria that business owners should consider shopping around.
"If you are a younger company, pre-revenue or low revenue — but plan to grow very quickly due to the industry that you're in (e.g., health care, IT or software consulting) — then a traditional bank loan may actually limit your growth," Adam said.
To decide whether a bank loan is right for your business, research both traditional loans and alternative funding sources. It's also important to know your business inside and out.
"If you anticipate steady growth over the next few years, then a traditional bank may be best," Adam said. "If you are growing like crazy and you know you will need to keep increasing your loan size by large increments each quarter, then entertain a nonbank lending partner, as banks may not be able to keep up with your needs."
Myth No. 5: The more money you ask for, the less likely you are to be approved for a small business loan.
The requested principal amount of the loan should not have an adverse impact on whether or not you’re approved. Lending institutions are generally prepared to fulfill large financing requests for the right borrower; it’s more lucrative for them in the long run anyway. Don’t be afraid to ask for the amount of money that you really need!
According to Jess Harris, content and social manager of business lender Kabbage, a working paper from Harvard Business School revealed that banks prefer lending larger amounts because they make more profit from large loans in the long run. In turn, banks are cutting back on smaller loans.
Evan Singer, general manager at online Small Business Administration loan program SmartBiz Loans, said a business should apply for the amount it needs — no more and no less. He recommends considering both how much money you really need to grow your business, and how much money you can afford to pay back every month.
"Make sure that you have cash flow to make your loan payments," Singer said. "That's the biggest thing that a [lender] is going to check — that [the business owner] can actually afford to make their loan payments."
Myth No. 6: The most important factor to look at is the interest rate.
It's easy to hyper-focus on the interest rate of the loan. Essentially, the interest rate is telling us just how much this money is going to cost us by the end of our repayment period. It’s certainly a crucial piece of information, but it’s just one aspect of the entire deal.
Although interest rates are an important aspect to consider when choosing a lender, there are many other factors to keep in mind. Harris suggested asking what the terms of the loan are, how soon you need to repay the money, and what you can use the loan for.
Ready to choose a loan? Visit Business News Daily's list of the best alternative small business loans.
Additional reporting by Sammi Caramela and Elizabeth Peterson. Some source interviews were conducted for a previous version of this article.